Microsoft Describes Profit Strategy at Citigroup Event

Chris Liddell, Microsoft's CFO, faced some pointed inquiries about Microsoft profit-generating strategies at the New York City-based event, which was sponsored by Citigroup. The banking concern recently showed some profitability of its own in its second quarter report after receiving $45 billion in U.S. taxpayer money through the Troubled Asset Relief Program (TARP) in October.

Despite the tough economy, Liddell said that Microsoft has seen good performance in the June quarter (or the end of Microsoft's fiscal year) on enterprise licensing renewals.

"We are incredibly happy that the renewal rates we are able to achieve in the enterprise were in line with what we've been able to achieve historically. But it's a very difficult environment," Liddell said. "People are very much subscribing to the value proposition that we have as a company."

Microsoft has been moving more toward a subscriber-based licensing model with its software-as-a-service business line, which Liddell characterized as a "high-growth area in the next five-plus years." The online services business model, which typically involves monthly fees rather than annual fees, provides a stronger connection to the customer compared with Microsoft's traditional annuity model, "although it hurts us from an accounting point of view up front," he said. However, Liddell admitted that Microsoft's Software plus Services model implied lower margins for the company.

Some of the questions honed into Microsoft's competition in the online search space. Liddell was asked how much Microsoft was willing to spend to catch up with No. 1 search competitor Google. That question was answered by Microsoft's CEO Steve Ballmer last year, who suggested Microsoft might spend "at least $1.2 billion or $1.5 billion a year to stay competitive." At the Citi event, Liddell replied that Microsoft has already budgeted for search and that it's been flat year over year. Microsoft's launch of Bing and its deal with Yahoo were conducted primarily to gain market share in search, he explained. For Microsoft, "a one percentage share gain [of the search market]… certainly would be a huge share gain for us," Liddell said.

Liddell answered a lot of questions about Microsoft's strategy on netbooks -- which are the low-cost, low-tech, laptop-like devices that threaten to cut into Microsoft's client operating system profits. Liddell noted that despite the low cost of netbooks, people are willing to pay for the Windows experience, citing a 92 percent attach rate. Netbooks are currently sold with either Linux or Windows Home Edition, but Liddell suggested that there's a potential for Microsoft to profit from users of Windows 7-based netbooks who would be willing to upgrade to higher priced editions of the operating system.

Liddell dismissed the threat of Linux against the possibility that Windows 7 will be higher priced than Windows XP on netbooks.

"The average price for Windows … is around $60," Liddell said. "For a four-year experience, it's about $15 per year. There are very few people in this room or that I would talk to who would learn an entirely new operating system with less functionality and less applications for the price $15 per year. So this is not an expensive product."

Microsoft expects to face "relatively tough" times through the rest of the calendar year, Liddell said. Still, people will eventually need to buy computers, and Microsoft expects to see a potential for "hardware refresh cycle" maybe next year.

Liddell may have disappointed the financial analyst crowd by saying that Microsoft's headcount reductions would be "broadly flat for the foreseeable future." He said that Microsoft did not increase salaries this year and has cut expenses associated with travel, contracts and vendor-spending costs.

Liddell's talk at the Citi event can be heard at Microsoft's investor relations Web site here.